Netscout Systems Inc (NTCT) 2016 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to NetScout's third-quarter, fiscal year 2016 results conference call.

(Operator Instructions)

As a reminder, this call is being recorded. Andrew Kramer, Vice President of Investor Relations and his colleagues at NetScout are on the line with us today.

(Operator Instructions)

I would now like to turn the call over to Andrew Kramer to begin the Company's prepared remarks.

Thank you Tanisha. Good morning everyone. Welcome to NetScout's fiscal year 2016 third-quarter conference call for the period ended December 31, 2015.

Joining me on this morning's call are Anil Singhal, NetScout's Co-Founder, President and CEO; Michael Szabados, NetScout's Chief Operating Officer; and Jean Bua, NetScout's Executive Vice President and Chief Financial Officer. We've included a slide presentation that accompanies our prepared remarks.

For those listeners who've dialed into the call this morning and would like to view the slide presentation you can find it by going to our website at www.NetScout.com/investors and then clicking on today's webcast. It's also available on the landing page of the investor relations site.

You can advance the slides on the webcast viewer to follow along with our commentary. We'll try to remember to call out the slide number we are referencing in our remarks.

As you know, our third-quarter results reflect the first full quarter of combined operation since completing our acquisition of Danaher's communications business in mid-July. In terms of the agenda for today's call, Anil Singhal will share his perspective on our third-quarter results and more importantly offer his perspective on our outlook for the remainder of the fiscal year, particularly as it relates to the opportunities and challenges that we believe lie ahead.

Our COO Michael Szabados will offer some insights on near-term integration activity and key drivers for customer adoption. Our CFO Jean Bua will then provide additional detail on our third-quarter financial performance as well as discuss our guidance.

Let's move on to slide number 3. I would like to remind everybody listening that forward-looking statements in this conference call are made pursuant to the Safe Harbor provisions of Section 21E of the Securities Exchange Act of 1934 as amended and other federal securities laws.

Investors are cautioned that statements in this presentation which are not strictly historical facts constitute forward-looking statements which involve risks and uncertainties. Forward-looking statements in this communication are made pursuant to the Safe Harbor provisions of Section 21E of the Securities Exchange Act of 1934 and other federal securities laws.

Investors are cautioned that statements in this communication which are not strictly historical statements including without limitation the statements related to the financial guidance for NetScout, statements related to the Company's future stock repurchase activities, expectations regarding future financial performance including gross margin and the ability to mitigate the impact of any revenue shortfalls, continued availability of additional amounts under our credit facility, expectations regarding improved penetration into and across our customer base, product development plans and timing, integration activities, cost controls and our plans and expectations through fiscal year 2017 and beyond constitute forward-looking statements which involve risks and uncertainties. Actual results could differ materially from the forward-looking statements due to known and unknown risks, uncertainties, assumptions and other factors.

Such factors include slowdowns or downturns in economic conditions generally and the market for advanced network and service assurance solutions specifically, the volatile foreign exchange environment, the Company's relationship with strategic partners, dependence on broad-based acceptance of the Company's network performance management solutions, the presence of competitors with greater financial resources than ours and their strategic response to our products, failure to comply with the financial or other covenants under our credit facilities, changes in the various factors impacting the Company's decisions regarding timing and volume of stock repurchases, our ability to retain key executives and employees, lower-than-expected demand for the Company's products and services and the ability of NetScout to successfully integrate the merged assets and associated technology and achieve operational efficiencies. For a more detailed description of the risk factors associated with the Company, please refer to the Company's annual report on Form 10-K for the fiscal year ended March 31, 2015 and the Company's subsequent quarterly reports on Form 10-Q which are on file with the Securities and Exchange Commission. NetScout assumes no obligation to update any forward-looking information contained in this communication or with respect to the announcements described herein.

Finally, I would like to remind you all that while the slide presentation includes both GAAP and non-GAAP results, unless otherwise stated financial information discussed on today's conference call will be on a non-GAAP basis only. Non-GAAP items are described and reconciled to the GAAP results in today's press release and they are included at the end of the presentation that is made available online and our website.

As Jean will note, the timing and magnitude of the acquisition will skew period-to-period comparisons and potential discussions related to growth rates. If we do note the growth rate we will strive to clarify the nature of the comparison.

As detailed in our press release today, NetScout reported strong third-quarter results as our non-GAAP revenue and EPS exceeded our plans entering the quarter. However, we have revised our fiscal year 2016 revenue targets downward to reflect current market conditions while also refining our non-GAAP EPS guidance within the range of our original guidance.

We know you likely have many questions about this as well as other areas of interest. So I'll turn the call over to Anil at this point to start us off. Anil, please go ahead.

Thank you Andy. Good morning to everyone listening and thank you for joining us today.

As Andy mentioned I'll briefly recap our results this quarter and then discuss the current market conditions and their impact on our outlook. I will also review our quarterly highlights as well as provide an update on some of the activities and initiatives that we anticipate will play an important role in shaping our performance as we look ahead to fiscal year 2017.

There are three slides that will accompany my comments. So please refer to slide number 5.

For the third quarter of fiscal year 2016 we generated non-GAAP revenue of $333.4 million which was ahead of our plan due to the strong revenue performances in our service provider and enterprise markets. At the same time we remain disciplined with regard to our cost structure while funding key development, sales and integration initiatives. As a result, our profitability at both the gross and operating margin levels came in ahead of our plan, enabling us to report a non-GAAP EPS of $0.58 per diluted share.

We also generated good free cash flow this quarter. Jean will be covering our quarterly performance in more detail later on later in the call.

It was almost six months ago in mid-July 2015 that we completed our acquisition of Danaher's communication business. Since that time we have made important progress on a wide range of activities and initiatives. The sales teams focused on our two target markets, enterprise and service provider, have been fully integrated, enabling us to present a unified message to our customers. In terms of product integration the first major milestone in our long-term product roadmap is on track and we plan to have the first phase of the combined service assurance solution ready for selling this spring.

Various other integration activities spanning marketing, manufacturing and back-office systems that support the business and our employees have progressed on schedule. We are on the path to complete some of the other major integration milestones before the end of fiscal year. Michael will provide more detailed details on this later.

Our leadership position in the marketplace continues to strengthen as a result of our broader customer base, global reach, powerful combination of proven technologies and domain expertise in solving many of the complex problems that our customers are facing. In addition, the employees of the acquired businesses are enthusiastic about our strategic direction and the opportunity at NetScout which has enabled us to enjoy very strong attention retention, particularly at the most senior level.

Finally, I have spent time with virtually every Tier 1 service provider that we work with around the globe during the past six months to better understand their strategies and challenges. They are excited about the product vision and the roadmap that I shared with them. I'll be doing a similar outreach with our large enterprise customers over the coming months.

Turning to slide number 6, I would like to discuss our outlook. Based in part on some of those initial customer visits in the summer and early fall, we noted on our last investor call that the service provider spending environment appeared to be quite fluid with slightly elongated purchasing cycles. Nevertheless, as we move through the third quarter and up until very recently we still believe that NetScout was on track to achieve its fiscal year 2016 financial targets with the low end of the original revenue guidance range viewed as a reasonable floor.

In addition to a robust third quarter, we are counting on a very strong finish to our fiscal year since most Tier 1 service providers typically allocate meaningful capital at the beginning of the new calendar year in conjunction with supporting their other projects. However, we believe the uncertain macroeconomic environment is causing concern among our customer base regarding their own plans for the calendar year 2016.

During my recent travels and as part of my recent dialogue with a number of large service provider customers during January we now believe that there is a bias from some of our large customers towards preserving their capital budgets in the first calendar quarter. As indicated by recent news the 2016 capital spending forecast from major Tier 1 service providers indicate a relatively stressed capital cycle.

Related to this, as the pressure on our customers' operating and capital budget intensifies we are now starting to see the potential for slower progress on some of their projects with longer cycles and order delays. These new dynamics have changed the timing and magnitude related to some of the larger projects that were going on at some of our global Tier 1 service provider customers. We estimate that these changes will negatively impact our expectation for the fourth quarter by over $50 million.

These customers still value our solution and are excited about our expanded technology capabilities. However, from a business perspective, their funding processes have slowed significantly as they are focused on incremental cost containment for the time being. We see that some of these projects are still moving forward but at a slower pace or with a change in the scope of the projects.

As a result of extensive discussion with both our customers and with our business and sales leader we have come to the conclusion that it's prudent to take a more cautious view on our near-term revenue outlook. And thus we have lowered our fiscal year 2016 revenue guidance to be between $1.015 billion to $1.025 billion.

We are, however, committed to preserving our earnings performance to the greatest extent possible. Despite the anticipated reduction in our full-year revenue we believe that we can still maintain a healthy full-year operating margin and deliver an EPS performance that's still within the range of our original guidance.

To mitigate the impact of the revenue shortfall to earnings we'll continue to vigilantly monitor expense levels across the board. This includes tightly controlling fourth-quarter discretionary spending and carefully managing the pace and timing of any hiring.

Additionally as we continue to advance the planning process for the next year, we'll be focused on accelerating margin improvement in fiscal year 2017. To do that we plan to closely examine our cost structure in combination with advancing our new product development initiatives which we believe will help drive notable improvement in gross margins next year. In the interim there are a number of recent highlights that we should not lose sight of in addition to the high level integration progress that I previously mentioned outlined.

Let's move to slide number 7 for that. In the service provider segment we supported our existing Tier 1 service providers in North America during the third quarter in their efforts to keep pace with higher traffic volumes and deliver high-quality, next-generation services such as voice over LTE. And as Michael will detail, we continue to see carriers outside of North America turn to NetScout to help them rollout their 4G networks, although the pace of these rollouts, particularly in Europe, has still been relatively slow. In addition we are seeing notable growth in spend from our cable MSO customers who are extending the scope of our engagement to include monitoring of their WiFi infrastructure.

We also continue to gain traction in this market segment with complementary products that enable end-to-end visibility. These include our packet flow switches for efficient aggregation of network traffic and radio access network optimization tools for diagnosing and troubleshooting network and device issues and understanding real-time traffic trends and minimizing costly and time-consuming manual testing of the mobile radio network.

Our end-to-end network monitoring capabilities are further complemented by our security division Arbor Networks. Arbor had a strong quarter overall with good growth in the service provider segment as a number of Tier 1 customers expanded their deployment of Arbor's solutions to keep pace with the growth of traffic over their networks and the needs of their end-user customers.

We also made good progress on the development and introduction of an integrated probing solution. As we've discussed on prior calls, our integrated product which we will call the Infinistream NG for next generation will integrate support for the best-in-class troubleshooting software from Tektronix Communications in addition to the innovative, proactive IP monitoring from NetScout.

The platform's support for the TekComms troubleshooting capabilities has begun testing and we expect it will be generally available on schedule in early spring to coincide with our Annual User Conference in May. We believe that adoption of this platform by our service provider customers will be a key driver for improving the Company's gross margin in fiscal year 2017 even in a tighter spending environment.

In our enterprise segment, we continue to benefit from solid demand from nGeniusONE in the government vertical as well as in manufacturing and business services. Our performance in the financial services sector has remained relatively lackluster, although revenue was up notably over the second quarter. We continue to see softness in this sector as financial institutions prioritize their spending on key compliance and security initiatives.

Nevertheless, we remain confident in our ability to improve our penetration across our customer base and we are advancing a number of product development and go-to-market initiatives that we believe will help us drive sustainable growth in the enterprise segment as we move through fiscal year 2017. One example of this is the effort to integrate nGenius with certain features and functionality from Fluke's systems products most notably their TruView. We expect to bring some of these capabilities to market with the next release of nGenius this fall.

In security we continue to see healthy demand for Arbor's DDoS or denial of service attack solution by enterprise customers across a range of industries, most notably financial services, retail and education. As we move forward Arbor is planning to launch a new product later this quarter that will extend its capabilities beyond DDoS by targeting a different network security challenge which is advanced persistent threat.

Arbor's advanced threat solution is designed to enable enterprise organizations to more effectively find and quickly contain security breaches. We believe that Arbor's scale, visibility into and understanding of the world's most complex networks and their sophisticated analytics will enable us to gain traction in what is currently a fragmented marketplace that is expected to grow rapidly over the coming years.

I would like to offer a few closing comments before I turn the call over to Michael. Over the past three decades NetScout has managed through the multiple market downturns and come out the other side in a stronger position. I believe that we are far better positioned today to navigate the current environment than in years past.

The technology trends impacting our customers today and into the future including virtualization, digital transformation and big data are very exciting and fast moving. We believe that our technology will be an important asset in their ability to embrace these trends and thrive in an increasingly connected world.

We remain confident that our experience, leadership, breadth and depth of innovative solutions, operational scale, excellent financial foundation and long-standing customer relationships will continue to serve us well moving forward. And while failure to meet our top-line targets due to worsening market conditions during the first year following our acquisition of the Danaher Communication business is disappointing, we still expect to deliver a strong operating margin and non-GAAP EPS performance that we will build upon going forward.

We believe that a more accurate reflection of the performance of the combining companies will become apparent in fiscal year 2017 and beyond. We are in the early stages of an exciting transition from legacy products to integrated solutions that we can leverage our differentiated software technology, drive further traction with customers worldwide and help us accelerate margin improvement moving into the next fiscal year.

Although the market conditions are difficult at the moment, we remain enthusiastic about our strategic direction and the many exciting initiatives now underway that we expect will play an important role in our ability to create significant value for all of our key stakeholders over the long term. Although we do not yet have a clear view on how the environment could impact demand levels in fiscal year 2017 we will move into the next fiscal year starting on April 1 with an eye towards realizing the promise of the acquisition in terms of extending our market and technology leadership in a larger total addressable market, innovating to meet the evolving needs for our expanded customer base and leveraging our global scale.

We plan to be focused on taking the necessary steps to accelerate margin improvement, showcase our earning power and generate strong cash flow even if we are operating in a slower growth environment for a protracted period. We are very excited about our future plans in terms of new products and new go-to-market strategy and continued integration progress. We will share more details about our plans for fiscal year 2017 when we report our fourth-quarter and full-year results in early May.

With that said I will now turn the call over to Michael.

Thank you, Anil, and good morning everyone. Slide number 9 provides an overview of the areas I plan to cover.

First, I'd like to provide an update on our integration efforts. Next, I will highlight some key customer wins that we believe help showcase NetScout's value proposition in the marketplace. I will close by reviewing some of the go-to-market highlights that we believe will further contribute to fortifying and expanding our market leadership.

First in terms of our integration initiatives, we have made good progress with our efforts to separate from the transitional services agreement with Danaher Corporation. At this point we have discontinued many employee-related support items and we are on track to integrate the Fluke and VSS enterprise systems into NetScout's enterprise system by this summer.

We are also on track to bring Fluke's manufacturing process for its monitoring systems in-house to our existing facilities in Westford, Massachusetts. We also expect to migrate production of Fluke's portable tools product lines to a trusted, high-quality contract manufacturing firm within this quarter.

In addition we are planning to have our service provider and enterprise sales forces on a common CRM platform along with the related sales compensation platforms at the end of this fiscal year -- fiscal quarter. This will represent a major milestone in our plan to ultimately realize synergies from our infrastructure support organizations.

We are also advancing the crosstraining activities required to maximize the productivity of the service provider and enterprise sales forces that we integrated last quarter. We expect that this investment will play an important role in further harvesting existing customer relationships and expanding our customer base next year.

In terms of our progress with customers, there are several wins during the past quarter that further validate the investments we continue to make in R&D to address the evolving needs of our customers and further differentiate our offerings in the marketplace. Although the service provider selling environment has become more challenging we are seeing that joining forces with Tektronix Communications is resonating with customers. For example, one Tier 1 service provider recently returned to NetScout after several years and has made multimillion dollar purchases for the past two quarters after concluding that its use of an alternative solution was unable to live up to the expectations.

And while the initial buildout of the 4G networks in North America has been largely accomplished we continue to pursue and win new networks outside of the United States. In South Asia we are working diligently to support the upcoming launch of a new state-of-the-art 4G network. This project will rely on a wide range of products from NetScout that include packet flow switches, instrumentation for monitoring and troubleshooting, customer experience management analytics and eventually some of our integrated capabilities.

Turning to the enterprise, as Anil mentioned our traction remains very strong in the government sector and we continue to enjoy robust growth in this past quarter. One of the drivers was a recently completed multimillion dollar project for a branch of the US military. This project involved upgrading and expanding their use of our nGeniusONE solution which includes our instrumentation, our unified communications solution and collaboration solution, packet flow switches and security.

Another great success story is our relationship with one of the largest not-for-profit healthcare organizations. Over the years they have continued to expand their use of nGeniusONE and this past quarter they made a multimillion dollar investment in our packet flow switches and probes to monitor the data centers that support its electronic medical record system that is widely accessed by doctors, nurses, staff and members.

In terms of security Arbor Networks brings a wealth of domain expertise to our organization. Last quarter we highlighted Arbor's investment to significantly enhance and expand its product portfolio to address a wider range of customer requirements including new on-premise and cloud capabilities that provide enterprise customers with greater deployment and cost flexibility.

We are pleased to see that these developments are already producing tangible results. This quarter Arbor won a highly competitive deal with well over $1 million with a major European financial services organization. The customer wanted a multilayer deployment scenario and Arbor Cloud was the choice.

Arbor Cloud delivers integrated, on-premise protection against a stealthy application layer attacks with cloud-based protection against large DDoS attacks. Arbor's continued investment in DDoS protection is the reason why they have been the market leader for more than a decade.

As we move into the final quarter of fiscal year 2016 we continue to drive thought leadership and build broader awareness of the Company as a market leader. NetScout once again made the Software Magazine's top 500 list as one of the five largest infrastructure and network management providers. Arbor's leadership in the DDoS market was reaffirmed by Infonetics which recently named Arbor as the top supplier of DDoS mitigation appliances overall as well as in the carrier, enterprise and mobile market segments in particular.

We are building on this type of recognition with a range of marketing programs aimed at elevating NetScout's message to the marketplace. We're also in the process of delivering a more consistent and cohesive Web presence across our various business units and we expect that this effort will continue to evolve as we move into next year. In addition, we are also planning to better leverage the digital marketing expertise we have gained with the inclusion of Fluke Networks to further advance our lead generation and cultivation programs.

That concludes my remarks at this point. I will turn it over to Jean for the financial review.

Thank you, Michael, and good morning everyone. This morning I will review our performance for the third quarter and then review our guidance for the completion of our 2016 fiscal year.

As a reminder our results this quarter reflect the first full-quarter contribution of the acquired Danaher Communications asset. There are a number of acquisition-related items that impacted our GAAP results so our convention will be to refer to our non-GAAP results unless otherwise noted.

On a related note and consistent with our comments earlier on the call, the timing and magnitude of the acquisition will impact comparisons with the prior-year period and any other extrapolations of our third-quarter results may not be representative. When possible we will frame our results against prior periods on a pro forma basis.

To begin our financial discussion we will be starting with slide number 11 of our presentation. For our third fiscal quarter total revenue was $333.4 million. As Anil noted, our revenue performance was accentuated by strong end-of-year spend by our customers.

We generated notable pro forma growth with our service provider customers that underpinned a pro forma FX neutral revenue growth of approximately 6%. Product revenue was $216.4 million, or 65% of total revenue, with service revenue comprising the remainder. This is generally consistent with last quarter's composition and largely in line with the information we shared at our Investor Day event this past summer.

Gross profit was $254.8 million. Our gross margin percentage for the quarter was 76.4% which reflects the overall product mix for the quarter that was skewed more favorably to nGeniusONE.

Operating income for the quarter was $88.3 million with a 26.5% operating income margin. This reflects the overall top-line performance of the business in combination with prudent expense management as we invested in the advancement of key integration, development and sales and marketing programs.

For the third quarter we reported net income of $57.2 million or $0.58 per diluted share which was $0.18 higher than the consensus estimate. A significant majority of the upside, nearly $0.15, reflected the operating leverage associated with the strong revenue performance.

Our non-GAAP tax rate for the quarter was approximately 33% as the benefit of the reinstatement of the R&D tax credit was partially offset by a geographic shift in income this quarter. Our repurchase of 700,000 shares of common stock during the quarter benefited earnings per share by a little less than half of a penny. The net income margin was 17.1%.

In terms of our non-GAAP performance for the first nine months, total revenue during this period was $715.9 million. Product revenue for the first three quarters was $450.7 million with service revenue coming in at $265.2 million. For the first nine months of fiscal year 2016, earnings per share was $1.47.

Slide 12 illustrates our revenue performance by segment for the third quarter and the first nine months of fiscal year 2016. My commentary will focus on the third-quarter performance since this is the first full quarter of reporting for the combined business.

Approximately 55% of total quarterly revenue came from our service provider segment with the remainder coming from enterprise. In terms of some color within the segment, legacy NetScout and Arbor turned in very strong performances in the service provider segment this quarter while TekComms was down slightly.

In the enterprise NetScout grew modestly which was more offset by declines in the enterprise revenue from Fluke and Arbor. Some of the year-over-year decline was related to the timing and magnitude of some large enterprise deals last year particularly at Arbor.

Let's turn to slide 13 for a review of revenue by geography. For this slide we will focus on the quarterly revenue mix which was 67% domestic and 33% international.

As previously mentioned, the relative strength of revenue from US-based service providers skewed the mix. Within our international third-quarter revenue Europe represented 17% of revenue with 7% for Asia and 9% for the rest of the world.

During the third quarter we had one customer that represented greater than 10% of revenue which reflects the contributions from multiple NetScout business units. No other customer represented more than 5% of revenue.

Slide 14 details our balance sheet highlights and free cash flow. We ended the quarter with cash, cash equivalents, short-term marketable securities and long-term marketable securities of $376.2 million which was up sequentially by $24.8 million.

In combination with the undrawn portion of our five-year evolver our liquidity exceeded $900 million. For the first three quarters of fiscal year 2016 our free cash flow was $50 million. Taking into account the timing of remittances from Danaher for certain accounts receivable collected under our transitional services agreement the free cash flow for the three quarters of 2016 would have been approximately $75 million.

Our free cash flow for the three quarters of 2016 has been negatively affected by certain one-time items involving the payment of approximately $24 million for business development and integration-related activities including investment banking fees and other professional services cost related to the acquisition. Our third-quarter fiscal year 2016 free cash flow was $52.3 million.

Accounts receivable net of allowances was $245 million. At the end of the prior quarter accounts receivable was $165.1 million and at the end of our last fiscal year 2015 accounts receivable was $82.2 million. The increase in accounts receivable from the prior year-end reflects the incremental receivables from the acquired business.

The sequential increase in accounts receivable represents the increased revenue in combination with the increased service renewal bookings. Days sales outstanding was 71 days for the quarter versus a DSO of 62 days for the same period in the prior year. The increase reflects the timing of billings in this quarter.

Our total deferred revenue was $312.4 million and trended across the combined Company's operations consistent with our expectations entering the quarter. Our primary financial objective is to maximize total shareholder return and we consistently evaluate our share repurchase activities as well as other value creating vehicles such as M&A, strategic partnerships and dividends.

Our ongoing capital allocation policy incorporates detailed financial planning and analysis and we consider multiple factors including operations, strategic business investments, prudent leverage, liquidity, free cash flow, cost of capital, market conditions and other metrics. We strive to maintain a strong financial profile in accordance with certain metrics which includes a liquidity range between two to three times EBITDA, cash on hand between a range of $350 million to $500 million and gross leverage in the one to two times EBITDA range.

Our capital deployment priorities are to maintain financial capacity to further invest in our product development either through in-house development or through acquired technologies. We currently seek to distribute excess cash flow to our shoulders through share repurchase and our target share repurchase strategy relies on three primary components. The first component is compensation neutrality which is oriented around repurchasing shares issued for employee compensation; the second component is opportunistic repurchases based on market, economics and other conditions; and the third component is overall prudent financial management for any excess capital.

To that end during the past three years we have continuously repurchased shares representing the compensation neutrality portion. This past quarter we repurchased 700,000 shares for $24.7 million.

For the three quarters of fiscal 2016 we have repurchased 5.3 million shares for a total of $203.8 million. At this time we currently anticipate being active in the market during our fourth quarter.

Let's turn to our guidance for fiscal year 2016 on slide 15. As we outlined in today's press release, NetScout updated its fiscal year 2016 guidance. Our guidance today reflects the Company's progress to date, our updated view into the fourth quarter as well as modifications to certain acquisition-related accounting adjustments and the impact of share repurchase activities through the third quarter of fiscal year 2016.

Focusing more specifically on our non-GAAP guidance for fiscal year 2016 as Anil noted we are sensitive to the service providers spending pressures given the current macroeconomic environment. When we spoke on our October call we saw a range of opportunities that supported our reaffirmation of the original non-GAAP revenue guidance. However, as Anil described despite the strong performance this quarter we now expect to fall short of our original revenue guidance targets and we have revised the range accordingly to reflect a more conservative view of the closing of certain large projects related to our service provider customer base.

Our original full-year guidance ranged from $1.050 billion to $1.1 billion. Our revised full-year revenue guidance now falls between $1.015 billion and $1.025 billion. This full-year guidance implies fourth-quarter revenue in the range of $300 million to $310 million.

To further echo Anil's earlier comments in terms of profitability, we are committed to preserving our earnings performance in spite of a very disappointing revenue shortfall. We've traditionally been disciplined with regard to expense management and that will continue into our final quarter of the year. We believe that controlling discretionary spending activities and carefully managing staffing levels will help dampen the impact of lower revenue.

Our prior guidance for non-GAAP net income per diluted share guidance ranged from $1.82 to $1.97. This had been adjusted at the end of our last quarter to reflect the share repurchases made through that date. We now anticipate that non-GAAP net income per diluted share will be in the range of $1.82 to $1.90.

In terms of more detailed modeling assumptions with regard to the tax rate, we anticipate a full-year effective tax rate in the range of approximately 34% to 35% which is lower than our prior range due to the reinstatement of the R&D tax credit. We expect the average weighted diluted shares outstanding for fiscal year 2016 to be close to 99 million shares in the final quarter with the average weighted diluted shares for the year being around 83 million.

Within our guidance reconciliation of GAAP earnings to non-GAAP earnings that is provided on slide 16 there are a couple of items with noting. First, we incurred $5.8 million of business development integration expenses in the third quarter which primarily represents one-time costs associated with certain integration activities going forward. These expenses are primarily associated with the use of outside professional firms related to transitioning from certain support agreements with Danaher. We expect this line item to be $2 million next quarter and we will factor this into our FY17 guidance accordingly.

Secondly, the deal-related post-combination services cost of $8.9 million in the third quarter represents the costs associated with the retention programs put in place by Danaher for certain of Danaher's former employees. These former Danaher employees were part of the transition plan to NetScout as a result of the transaction. There is one retention program still outstanding and it will continue through the second quarter of the next fiscal year.

Although these costs are fully reimbursable to NetScout by Danaher under GAAP guidance they are required to be expensed given that they relate to a period after the close. Hence these expenses are considered compensation under GAAP reporting requirements. We anticipate that the additional milestones related to these programs will impact the fourth quarter by approximately $3 million.

That concludes my formal review of our financial results. Before we transition to Q&A I would like to reiterate to our shareholders that we will continue to be proactive in helping them understand our business in the context of both the near-term and longer-term challenges and opportunities in front of us.

To that end we will be on the road in February visiting current and prospective shareholders in Baltimore, Boston, New York and Chicago. We will also be presenting at the Wells Fargo Cyber Security Conference on February 17 in Boston.

That concludes our prepared remarks this morning. Thank you again for joining us and we're not ready to answer questions. Tanisha, you may now begin the Q&A session.

(Operator Instructions) Mark Kelleher, D.A. Davidson.

Great, thanks for taking the questions. The macro weakness that you're seeing from the service providers, is that service provider specific or are you seeing that in the enterprise as well?

No, we are seeing demand mostly in service provider only and mostly in Tier 1. And that's why -- that magnitude of difference we talked about. So mostly seeing it from the Tier 1 service providers.

As a follow-up, could that hesitation be related to the service providers waiting for a unified NetScout product for the new products or is this really macro?

No, it's really macro. And in fact the anticipation for the new solution is really good and they state that we are ahead of schedule.

So they are all very excited about it. But as we mentioned, as the new budgets got assigned for the calendar year 2016, we noted this pause in spending and second thoughts about on capital spending. And you probably are seeing some of the news items related to that already.

Okay, thanks. I will get back in the queue.

Alex Kurtz, Sterne Agee.

Hey guys, thanks for taking a couple of questions here. Anil, given the strength you saw with the service provider in the December quarter was there any pull-in from the March quarter into the December quarter and maybe that's creating a little bit of a pause as well as far as how you think about the remainder of fiscal 2016?

No, that's not -- we didn't see that pull-in from that but people were concerned about and we benefited from this end-of-year flush because they thought that -- and we later realized that some of the projects we did would have funded in early 2016. They tried to use some of the budget because they were concerned about what could happen with the budget allocation next year.

But that's more anecdotal and there was not a big pull-in from 2016. I think some of the projects are still in progress and hopefully some of them will materialize in the coming months.

And just to follow up before I get back in the queue here, I think the questions we are getting from investors this morning is trying to understand the extent and length of what you perceive here as this softness in the carrier business. Do you see this as a calendar 2016 event, Anil, or is it just something that you're noting as a first-half phenomenon as far as the weaker spend?

I think I will let Jean comment on that also. Like I said all this developed mostly in the last few weeks and we are still trying to assess that and I think we'll have more information as we provide guidance for fiscal year 2017.

So it's too early to assess that how long this will be. But as we mentioned regardless of how the spending climate is we think because of the product integration activities, the [combo pro] which we talked about and the gross margin improvement I think we'll overall faring better than other companies in our space because of those improvements.

Hi, Alex, this is Jean. As you know we've talked about in the past the service provider customer base that we have is always a tale of the individual service providers and exactly what they are doing in their strategies.

As Anil had noted in his comments in our pipeline in the project that we were working on there was more than $50 million worth of projects that were anticipated to close this quarter. We have been in conversations with probably at least four deals in there and we've been in conversations with all of these carriers and they are interested in their projects.

But what happened honestly in mid-January is that with all of the macroeconomic themes as I'm sure you know China and the Federal Reserve interest rate and the oil prices, a lot of the business side of these carriers decided that they wanted to be a little more prudent and probably focus more on liquidity. So they have put a halt to the funding of these projects.

Some of them are still ongoing and we're still in conversations with them. Some of them will probably change in the scope of their form or in the timing of when they roll out these projects.

So like everybody else in the world we're going to wait and see what the effect will be on those three major factors on the macroeconomic environment. And then as we do guidance we will update everything accordingly in the beginning of FY17.

Jean, before I hop off, that $50 million softness here, is it really related to these four deals, is that what I heard?

Yes. There were four major deals -- they were four major deals that are north of $10 million per deal.

Right.

Scott Zeller, Needham & Company.

Hi, thanks, good morning. On the same topic following up on the previous questions, I think we all could use some more color from Anil on what exactly is happening with service provider because there are a few things in motion here.

There's commentary about macro and how that's weighing on service provider. There's also on peoples' minds the issue of CapEx. And are those intertwined?

Are we seeing behavior driven by macro, are we seeing behavior driven by CapEx caution? Because I think it would be helpful to explain why previously NetScout as a standalone really did not move in line with CapEx commentary and CapEx behavior service provider. And if that's changing, help us understand why.

Good question, Scott. So the first thing is of the size of our business, the sheer size of our service-based business is almost three times than what it was as a standalone Company.

So obviously the impact on big projects will be more Tektronix Communications was much bigger portion of the business. But one other factor in addition to the macroeconomic themes which Jean was talking about is I think we spoke about last time is that what is going on at the service provider spending.

People have moved to 4G and LTE and you remember we had a lot of good business on both sides for Tek and NetScout in the past regarding that. And now people have deployed 4G they can really drive traffic because of OTT, over-the-top applications dramatically yet the providers are not getting paid for it. You can charge for OTT as a service but still you have to provide services.

So that is requiring them to upgrade their infrastructure for that. Some of them are doing that through virtualization and SDN, some of them are doing it by investing more, some of them are curtailing spending on other front.

So just like more network spending is required to upgrade to deal with higher bandwidth because of 4G and the last mile improvement, that affects the amount of stuff they need to buy for us. So it increases the opportunities but also increases the CapEx pressure.

So that's an additional thing going on on the service provider for quite some time. But when this all this macroeconomic issue they really said now it's now two big things and they want to think about how they want to manage this project and I think that combination is what is causing this sudden shift.

And just to follow up, Anil are you seeing differences in the way the Tektronix legacy deals were reviewed and the way that spend was viewed as CapEx versus OpEx versus the way NetScout deals were positioned? Is there a different attitude towards spending on these products from the Tek buyer versus the NetScout buyer?

It is not a CapEx versus OpEx difference but it was more about the way the pricing model and packaging work. So I think that was probably a bigger challenge for the standalone TekComms business and the way it was priced and packaged.

But our new solution coming out in the April-May timeframe which will be a combined solution we'll be using the NetScout packaging model but it will have the combined technology. So one of the challenge people had in the past and which we will not have despite this CapEx pressure is that if you have to put two pros on the same environment then you have even a bigger CapEx challenge. And I think we have solved that -- we'll be solving that problem and they don't have to pick between A and B, they can get A plus B virtually at a slightly higher price than A or B.

So there was a bigger pressure on the price because of the pricing model and the way it was sold and the deal sizes where much higher. And there were more hardware components. And that did create some change but it was not necessarily a CapEx versus OpEx issue.

Thank you.

Chad Bennett, Craig-Hallum.

Great, thanks for taking my questions. Can you just talk about, maybe Anil, I know you don't like to talk about specific customers but I know AT&T specifically was a fairly big customer of TekComms prior to the transaction.

Can you just, and I don't know if you probably don't want to mention it that that was one of the four deals, but kind of the relationship there and how you see that relationship as much as you can say over the next couple of years if it has a potential to grow? And then I have a follow-up to that.

Okay. So AT&T continues to be the top 10 customers and it continues to be a big customer. And this was not one of the four things which we talked about in general.

But overall we see the business with AT&T to be quite good in the coming year but in line with what we have been seeing in the recent past. It's not something of the order of what TekComms used to do two years ago.

It was very high. So I think it's going to be one of the many big Tier 1 customers. And it's not necessarily the reason why these issues are what we are talking about are there in terms of revising of our guidance.

Okay. So great that's good detail.

And the second question is do you think the service provider cautioned that you've talked about it sounding more cyclical or short to medium term in nature and just had a caution on CapEx and whatnot. So do you truly believe that which you obviously stated or is there something more secular in nature in terms of erosion via NFV or software-based monitoring solutions that are just grabbing more dollars?

And if that is the case, you probably don't think it is what is your response to an NFV solution that handles network monitoring? Thanks.

So the first thing is yes there is a lot of talk about an NFV but very little deployment. And we are the only Company who actually have an NFV product. And we have come up with a pricing model which could be really beneficial to the long-term success because you can come up with a software pricing model.

So as we talked about we already announced the software pricing model with or without NFV but not many people are biting on it. I think there is a lot of talk about it but there is no business there and if there were they'd probably come to us.

So our (inaudible) technology today is available both in the [the plant form, in the card form] it is commercial off-the-shelf as well as in the NFV form. And all three models will be available in this combined solution. So I don't think there's any impact of NFV and if there was actually if that is a way to mitigate CapEx issues we'll be in the front of the line.

Okay. Thank you.

(Operator Instructions) Kevin Liu, B. Riley.

Hi, good morning. Anil, just wanted to follow up on the last point you made there about NFV and your progress there. So you guys do have the ability to offer virtualized probes at present and you're able to address some of the monitoring solutions for functions that have been virtualized already?

Yes, that's right. But the part of the -- the part of the infrastructure which is virtualized is a small fraction of the overall capital budget and the size of the network.

So we are having a product that doesn't necessarily drive big revenues right now because everyone is experimenting with this. They look at this way of cutting down their CapEx and essentially that will cut down the size, the price per probe for NetScout which you'll think like is very disruptive but actually it will increase the number of places they'll use our solution.

So the number of probes times our price per probe comes down but the number of probes they can deploy effectively is going to be actually a good thing.

So we love the fact that and we are ready for it. Unfortunately or the timing is such this is a five-year cycle to transition from the legacy infrastructure to hybrid to next-generation and we are in the early phases of the hybrid. And that's why this is not necessarily having an impact on what's going on to our business or in the marketplace.

Hi, Kevin, this is Jean. Just to add on to what Anil is saying, you know at the heart of what NetScout is is we are about business information and intelligence, operational intelligence.

And the software has always been the product differentiator and the key driver for why customers buy our product, the ability obviously to be proactive. And through Anil's product roadmap from years ago the software has always been the key component. And it really has only been on a data capture because that's the way the industry went in the past.

As Anil said, we are NFV and SDN ready now because for us to decouple from off-the-shelf commodity hardware was not really difficult at all. So we actually look forward to NFV and SDN and a lot of the other future trends, big data, digital transformation because what Anil is envisioning is that our software will be able to go in so many more places where it never went before.

And an example of one of the more extreme endpoints would be in people's homes in some of our WiFi-enabled customers. And we'll be able together so much more information and be such a better complete solution to our customers that we're very excited about the opportunity and the trends in the future.

Understood. And if I could just ask a quick follow-up on that, as these transitions to NFV and SDN start to happen and obviously some of the larger Tier 1s maybe experimenting in the labs currently one, do you see a new kind of competitive set starting to emerge outside of your traditional competitors? And then two, a large carrier like AT&T it does seem like they have possibly started to evaluate some solutions and then there was one smaller vendor in the network monitoring space in particular that cited a virtual probe win. So I'm curious if you can address whether that was a situation you guys were involved with at all or whether you're not seeing those types of trials go on yet?

So just referring to the small vendor I think we are not going to find a price, simply price best deals. And so some people will win because in certain places because we simply decide to not compete in that business and I think that's what happened with that small vendor.

But coming back I mean this is people will come and go but we created the industry's first probe and we are $1 million in size in 1993. So much transition and turmoil has happened in the industry, the speeds have gone from 10 megabit Ethernet to 100 gig.

We had downturns. We had big acquisitions, small acquisitions and yet we are a $1 billion-plus Company and that's what's going to continue. So people will come and go, there will always be competition.

It's healthy. But we are very confident that we have the experience and the passion to really drive this market where it needs to be. And I think regardless of what happens to the market conditions we'll still be doing better than some of the other competitors.

Hi Kevin, it's Jean again. Just to add on, what Anil said is that we don't see really new competitors as we've talked about in the past few years.

When you go around the globe there are various amounts of competitors that are always smaller in nature and smaller in scale. But clearly it is an opportunity for a lot of people to want to continue to play in.

There's also larger enterprise customers that have greater scale than we do which was also one of the reasons why we wanted to do the combination of the Danaher TekComms business and NetScout was to be able to capitalize on that scale. So the competitive landscape is still probably relatively the same, differentiated by the lower, smaller scopes, regional geographical players to some of the very large infrastructure players who do it on a more broad but less quality way and then NetScout who is the pure play player.

Regarding some of the customers, some of the service provider customers who are thinking about trying to move into SDN and NFV, again the combination of NetScout and Tektronix we have a wealth of information that we feel in an area where people are moving into NFV there are many opportunities for us to play with that information. And may be a particular opportunity as Anil had said where it was more of a smaller deal and a more price-sensitive deal might not have been the right place for NetScout to play in that particular arena.

Understood, thank you. And I appreciate all the color.

Eric Martinuzzi, Lake Street Capital Markets.

Thanks. I was pleased to see despite the revenue guide down that you will be able to you're guiding within the original guided range on the EPS. Obviously when the revenue is not there it comes down to the expense management.

When the deal was originally put together you talked about 5% potential synergies and I know the deal wasn't synergies focused, it was about combining products. But that was originally equated to about a $45 million potential synergies number.

So A, is that still the right estimate for the synergies or is it potentially higher? And then B, where are we here just six months in in realizing those synergies?

Hi, Eric, this is Jean. I would say that the 5% is still our target. We are as Michael had noted making very good progress. The transitional support services that we're coming off of we are looking at efficient ways of processing so we're getting synergies in that space.

You also can see that the gross margin is starting to improve because we look at things in a very simple way and take things out that our more complex. As you know Anil over the years he's very focused at problem solving and gets to the heart of the problem. So we've been pretty pleased so far with our progress related to the integration in taking and looking at the cost and being able to simplify our processes and hence reduce cost with without sacrificing any service to our customer or any service to our internal employees also.

All right. And then as far as the progress there I mean I think it was expected to be realized in the first 12 months of ownership. Is that halfway there? Is that a correct number or are you two-thirds of the way there?

So we have said that we believe we would be able to take that amount out of the first full year of operations. So we are in say midway point at this part since it closed in mid-July. So we still have Q4 and a portion of Q1 to be able to achieve that original target goal.

Thank you.

We have no further questions at this time.

Great. Well I'd like to thank everybody for spending the past hour or so with us today.

We certainly look forward to speaking or seeing you in the near future. And we'll certainly be looking forward to our next quarter's conference call in early May. Thank you all very much for your time.

That does conclude today's program. We would like to thank you for your participation. Have a wonderful day and you may disconnect at any time.